Iran’s Capital Market Waiting
to be Given a Serious Shot
By Mahdi Goodarzi & Mojde Rezaee
Over the past decades, Iran’s economy has been suffering from challenges originating from its mere reliance on the banking system for finance; the situation now calls for more attention after the recent re-openings in the country since the JCPOA was hit because the country’s economic growth has been limited due to ignoring the capital market potential, which is interpreted as one of the major factors driving developed countries’ growth.
In search of another source of finance, policy makers and economic practitioners are now concerned with adopting proper policies and methods to overcome this credit crunch, among them lies strengthening the capital market role in financing the private sector through modern financial instruments.
Iran’s Bank-Based Economy
Currently, the banking sector is carrying nearly the whole burden of financing in Iran’s economy; it is so while the data on the facilities to deposits ratio as well as banks’ debt to the CBI demonstrate the need for creating a balance seeking other ways of financing.
As the above table demonstrates, a high amount of the absorbed deposits has been granted as loans while investigations prove low quality of such loans, which have resulted in NPLs and government debt to banks.
Since the bank-based nature of our economy has made banks dependent on the CBI, which might itself trigger higher inflation rates, the 11th administration announced and supported the launching of reforms in financing structures among its major policies.
Based on statistics, the money market played a 92.9%, 88.8% and 88.1% part in financing over 2011-2013 while the capital market had a 7.1%, 11.2% and 11.9% share of this market over the said period. It was so while such rates were as below in 2016/17:
In Iran, lack of a deep, developed and efficient capital market has put banks largely in charge of financing economic activities, which has resulted in the public having high expectations from them; this will become even more complicated when we find out that these banks have had access only to the limited internal resources. This has been worsened with governments obliging banks to provide different sectors with funds just to win their voters’ hearts, especially at the time of elections. All in all, these have gradually resulted in high NPL ratios, postponed/deferred claims and unhealthy financial statements of banks, such that within the past years, nearly 15% of banks’ resources have been stuck.
But we are now under conditions where banks are in dire need of fundamental changes and reforms in their structures and management to resonate with international standards to become eligible to join their foreign counterparts; although each bank has to play its own share in this regard, it is the Central Bank of Iran’s mere responsibility to make such happen.
Ups & Downs
Those in favor of a bank-based economy believe that this system can be more effective and beneficial in countries which are at the early phases of economic growth and lack the necessary legal and supportive requirements and frameworks in their capital markets; therefore, major banks have enough power to put pressure on companies for instance to release their financial information or settle their debts.
On the contrary, those proponents of a market-based economy assume that the stock market will facilitate the process of forming companies and absorbing investments, owing to enjoying higher levels of transparency, which eventually accelerate economic growth pace.
Iran’s Capital Market Recent Growth
During the past few years, the capital market has gone through significant growth while the banking sector has been grappling with imbalances in their balance sheets, soaking most of the absorbed resources depriving it from playing an effective role in financing. Furthermore, the lifting of sanctions is expected to introduce other developed financial instruments into the capital market adding to its depth and growth speed.
In fact, data has proved a more active role of the capital market in financing economic projects over the past years, coming to the help of the banking sector; this has been done directly via capital raise plans and issuing debt bonds among the used instruments as well as indirectly through improving the business environment, stabilizing companies’ profitability and the settlement of debts to banks. Besides, due to a multi-layered supervision in the market, the funds will be consumed in activities whose return rates exceed that of the financing process; in fact, feasibility of projects and activities seems to be more studied here than in the banking system. Not respecting such a principle is one of the main reasons of the freezing of banks’ assets and the growth of delayed claims in banks.
Why Based on Banks?
Among the reasons why Iran’s economy is based on banks is the economic officials’ traditional view as well as the public unfamiliarity with the capital market potential; traditionally, people has more faith in the banking system, believing that it is backed by the government; in fact, it is not generally accepted that one can lend money to a company and then, get back their principle plus interest at the maturity date. This is why there is always a bank when issuing bonds just to assure investors of the safe return of the principal and interest of the capital.
The easiness of accessing banking facilities by economic institutions is another motive to rely on banks when in need of finance. The long and to some extent boring process of issuing debt bonds, including the designing of bonds proper with institutions’ financial capacity, getting the required licenses from the SEO and/or other regulatory bodies, the issuance of the prospectus, the necessity of introducing a guarantor, etc. are of the turn-offs when resorting to the capital market for financing.
The stickiness of high interest rates on deposits paid in the banking system on one hand and the fact that such rates (mistakenly considered as the risk free rate) are usually set as the basis for bonds’ return rate on the other is interpreted as another impediment ahead.
Paying back the principles at the maturity dates will require huge piles of money, pressurizing the companies; besides, failing to do so on time will also scare companies to death, pushing them further away from the capital market as a source of financing.
Last but not least is the high rates on the services, i.e. underwriting, market making and guaranteeing, offered by financial intermediaries in the country, which ultimately result in high effective financing rates.
To make such happen, in addition to the following steps, banks’ structure must go through reforms, the capital market must be deepened and its active financial institutes like investment banks must also be strengthened; the latter do not appear to be possible right now mostly due to such institutes’ being small and not having large capitals:
- Making interest rate real, which calls for lowering the cost of money in the country; this, itself will be in need of reducing banks’ frozen assets mostly in the housing sector plus settling government’s debt to the banking system; for the latter, the government has issued Islamic Treasury Bills and is also eyeing the translation of foreign exchange. As the CBI’s statistics show, the government owes IRR 372,100 bn, IRR 474,800 bn and IRR 608,700 bn to commercial banks, specialized banks and non-state banks and credit institutions, respectively;
- Causing a balanced growth in transparency level in the financial system, both the banking sector and the capital markets; and
- Introducing credit rating agencies in the country to replace and act as bank guarantees: All bonds in the capital market are backed mostly by banks to assure that they will not fail; however, banks’ capability to guarantee is limited and cannot cover the whole capital market in an unlimited way. In order to encourage companies to issue bonds as well as taking into consideration the different status of banks, as the guarantors, the entrance of credit rating agencies seems to be extremely necessary do the rating based on their risk levels, which will eventually relieve banks from the burden of guaranteeing the bonds.
Considering the recent (and higher levels of) trust put in the capital market by the government (for instance through resorting to ITBs to settle its debt), the capital market is now placed on its development path and the banking sector is also getting gradually away from its traditional role as the sole financer of the economy. Now seems to be the time for reshaping the country’s economic structure by re-designing unified rules, regulations and procedures as well as re-visiting the financial markets structure with an eye on the capital market potential, having identified the current threats, opportunities, strengths and weaknesses; this, in fact, calls for explicitly defining the roles and parts of both the banking system and the capital market, which itself will provide and allow small to large sized enterprises in the country hungry for capital to be better able to see and plan their future to eventually bring about the progress and economic growth needed in the country.
DISCLAIMER: This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice.
To contact reporters: Inter@agah.com